What Happens to a Secured Loan in a Chapter 13 Bankruptcy?
Chapter 13 bankruptcy provides a legal way to consolidate your debt into a single monthly payment according to the terms of a repayment plan approved by a bankruptcy judge. Often, those repayment plans allow for more favorable repayment terms, such as reduced interest or reduced principal. Chapter 13 bankruptcy, however, affects secured debts in a different way than it affects unsecured debts.
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Secured Debt
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A secured debt is a loan attached to a certain piece of property. For example, if you take out a loan to purchase a car, the lender has a secured debt on your car because if you fail to make the loan payments as required, the lender can repossess the car and sell it to pay off the loan. Similarly, a mortgage is a secured loan on your house. A secured debt, then, is made up of two pieces: the loan, and the security interest in the property.
Loan
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When you file for Chapter 13 you have the legal right to discharge any debts leftover after you make all your required payments under your repayment plan. This means that the loan portion of the secured debt will disappear, or be "discharged," in Chapter 13 bankruptcy. In other words, after you fulfill your repayment plan you will no longer be legally obligate to repay the loan on your secured debt.
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Security Interest
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Even though your loan is discharged in Chapter 13, the lender still retains its security interest in your property. So, if you fall behind on your loan payments, the lender can still exercise its security interest in the property by repossessing and selling the property. Chapter 13 discharges your personal liability on the loan, but it does not discharge the security interest.
Deficiency
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When a lender repossesses property to pay off the loan, there is often a balance remaining after the repossession. This balance is called a deficiency. For example, you may owe $10,000 on your car loan, and your lender repossesses and resells your car for only $6,000, you will be liable for repaying the $4,000 deficiency. However, under Chapter 13, a lender cannot pursue a deficiency judgment against you. So, while the lender may repossess and sell your car, you will never be liable for a deficiency if you properly complete a Chapter 13 repayment plan.
Options
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You have a few options when you file for Chapter 13 bankruptcy. First, you can simply give the secured property back to the lender and walk away. Or, if you want to keep the property, you can "reaffirm" the loan by entering into a new agreement with the lender that says you agree to be personally liable on on the loan even after the Chapter 13 bankruptcy.
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References
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